Author: Minich MacGregor Wealth Management

As of last week, the major U.S. Stock Market Indexes had fallen approximately 7 percent from the September highs. These types of drops in the stock market aren’t uncommon. Almost every year — and some years, more than once — the market will drop 7 to 10 percent before stabilizing and starting its upward march again.

Exactly what triggered the most recent drop is anyone’s guess. Certainly events like the election, the ongoing European financial crisis and the looming “financial cliff” have kept the market on edge. Although we can’t really ever be certain of the cause, we can be sure of this: there have been a lot more sellers than buyers of U.S. stocks in the last few weeks.

Again, a 7-percent drop isn’t uncommon and if it turns around quickly, it’s certainly not a cause for panic. However, since we can’t tell if this drop is near its end or if it’s just the beginning of a much deeper and dramatic downward move, I would call it a cause for concern.

Given that, now is the time to closely review your investments. Look for investments that may be doing worse than their peers and rotate into those that have held up well during the recent drop.

Create an investment plan that includes an action statement such as, “if investment ‘x’ goes below a certain point, I’m going to sell it” — or alternatively, buy more of it, or simply hold. The key is to make those determinations now so that in the heat of the moment you don’t make a rash decision purely based on emotion. In the investment business, emotions can often override common sense and lead you astray.

If you are a conservative investor, selling a portion of your stock investments now to raise cash may make sense. A good question to ask yourself is this: “At this point in my life, which is worse? Selling now and missing out on a few points when the market turns back around? Or, not selling now and having the market go down another 15 to 20 percent?” Your answer will determine the appropriate action for you.

The good news is that no market goes down forever. Just as you need a defined, defensive response to an ongoing market, you also need an offensive plan. Start thinking about what action you will take when the stock market starts to go back up. Determine now what positive market events need to occur before you take action. Consider where you will re-deploy any cash you’ve raised. Examine your current stock investments with an eye for ones that are lagging on the upside. Determine if they should be sold and the money put toward faster growing areas.

Having a plan in place for market rises and falls allows you to respond in a manner that protects and grows your wealth. If you don’t have one already, take the time to create one or seek out someone to do it for you. After all, failing to plan is essentially a plan to fail.

Allow me to tone down the seemingly alarmist meaning of the words: “End of World Market”.  “End of World Market” refers to a style of portfolio management that treats most risks as a risk that has the potential to move the market to a 50% decline.  Pretend for a moment that you and I are living during the revolutionary war.  We live in upstate New York.  It is the beginning of the war.  After several initial skirmishes most able bodied men have joined the military effort.  Most families have moved into the fort.  The fort guards a long west and east view of the Mohawk River.  The location is strategic.  In this situation I am the private.  I am walking the parapet built at the top and behind the fort’s log wall.  The parapet allows me to walk guard duty all around the perimeter of the fort.  Luckily for me the platform keeps my body behind the wall, but every so many yards there is a gap in the wall that allows me to look out at the view to determine what events might be unfolding.  I have a perfect view at some locations up and down the river, but clearly the farther away the object the hazier the determination as to what exactly I can see.  This particular night, walking guard duty, I am approached by the Commander of the fort….you!  You look me in the eye and say: “Private with the war having just started, it seems like we have no friends, everyone is an enemy… the British, the Indians, loyalists, and possibly even the French trappers. You and I have an enormous responsibility.  We have given shelter to any of the families in the valley that want it.  We have all the soldiers stationed in the fort.  And, we have been charged with guarding the western frontier.  It is rumored that the British are planning a 3 pronged attack to separate the colonies.  The British could easily send an army from the west along the Mohawk River.”  My response is: “yes sir, the situation while stable tonight could easily become the most grave.  What are your orders?”  You the commander say, “Take no chances, if you see someone approaching, and you think they pose a danger, you are ordered to shoot.”  I say, “But, what if I am not sure?”  You say, “Pull the trigger!”  I say, “Yes but what if it is a mistake and I shoot a good guy?”  And you say, “That is just the risk we are going to have to take!”

“End of World” portfolio management is willing to take the risk that protecting against all risks may wind up being too cautious.  It would be an interesting lesson in market history to track down all the seemingly innocuous risks that have been the tipping point for an ensuing market decline.  In this case I am going to rely on your understanding that there have been plenty of those times.  Or more blatantly stated, there have been times where seemingly from out of nowhere the market and the economy have headed down.  Or more importantly, the decline as played out in your mind and your life has been a surprise.  

It is hard to believe that the revolutionary war was one long unending battle.  No breaks. Every day was cloudy.  The selection of native deer, trout, and turkeys simply disappeared into the woods.  It was gruel and hard tack for all.  In much the same way a money management strategy that is designed to be constantly vigilant may simply encounter sunny days… in fact long periods of sunny days.  A valid strategy must allow for positive periods in the capital markets.

The classic problem with static strategies is that they do not allow for flexibility.  Allocation strategies that hide behind the “Pie Chart” image are just those strategies.  As the commander of the fort, do you make one determination of risk that never changes?!  The war is nearly over, clearly the danger is less, but I (the guard) am still told to shoot to kill….even if they (the theoretical bad guys) know the passcode?

“End of World” Market management is a solution because it establishes in advance what the range of risk management is to be.  Let’s say that in the tightest of all situations, the percent allowed in stock is only 15%.  When we have a string of sunny days in the market the percent allowed is 60%. The range of risk management is 45%!  What is critical is that the guards are still posted.  The families may be out of the fort, holding a venison roast, but the guards are still looking for any sign that signifies they need to run for the fort.

“End of World Market” management is precisely that:  predesigned to be careful, any movement in the bushes is treated as suspicious and justifies returning to the fort; but, predesigned to allow for sunny days in the market.  My proposition is that money management strategies will work even when they are designed to be flexible.  And in the next articles you will see how clearly defined strategies like “End of World Market”, “Normal Market” and “Beat the Market” strategies can be present in the same overall portfolio.

Not surprisingly, saving for retirement is a popular topic of discussion for a financial adviser like myself. But what is surprising, at least to me, is the lack of true commitment most people make to retirement savings.

To that point, a recent survey by the Employee Benefits Research Institute (EBRI) found that 56 percent of American workers admit that they and their spouse haven’t even calculated how much they should have saved by the time they retire.

Not surprisingly, the same survey found that over half of Americans are either “not confident” or “not too confident” they’ll have enough money saved to live comfortably through their retirement years.

Unfortunately, retirement savings is not a “cross that bridge when you come to it” type of problem. If you don’t plan and save for retirement now, you’re not even going to have a bridge to cross in the future.

Saving is the key to your future comfort.

The Center for Retirement Research suggests that people need about 80 percent of their pre-retirement income in retirement to maintain their pre-retirement living standard. The savings rate needed to hit this target depends on several factors including earnings, the age at which you start saving, retirement age, and asset returns.

For example, the average earner who starts saving at 35 and retires at 67 needs to save 18 percent each year, assuming a 4-percent return. The comparable rate for low earners is 12 percent and for high earners the rate ticks in at 22 percent.

Those are big (and daunting) percentages no matter where you fall on the earnings spectrum. It is possible to notch the percentages down a bit if you start saving earlier and work longer, but the reality is still there — You need to save (more than you think) now to ensure you’ll have money to spend later.

If you aren’t coming close to saving at least 15 percent for retirement don’t roll over and give up. Instead, bump up your savings rate a percent or two each year for the next few years. Studies (or a compounding interest calculator) show that in the early and mid-stages of retirement savings accumulation, how much you save is much more important than investment performance.

Many of the factors that go into retirement planning are out of your control. You don’t know the exact age at which you will retire, you don’t know exactly how much money you will need, and you certainly don’t know how long you will live. The one thing you can control is your savings rate. Taking control of it today could lead to a much happier tomorrow.

Parenting skills may be at their most critical level during the early morning hours associated with the kids leaving the house and getting on the school bus.  “Bobby did you finish your breakfast?  Bobby did you put your homework back into your school bag so you can turn it in?  What about your lunch money?  Don’t forget that I will be picking you up at the athletic field after practice.  I just listened to the weather report: high likelihood of rain.  Please wear your rain coat!  What do you mean you don’t want to?  Just because nobody else wears a rain coat does not mean that you can’t. OK, how about taking my umbrella?  And please will you not leave my umbrella at school.  Please, do not sit in the back of the bus, sit up front where the bus driver can keep an eye on you.  (Bobby walking out the door….)  I love you, and please be careful.”

Notice how the parenting skills went from addressing specific risks to addressing the overall risk of “be careful.”  In money management, the major change over the last 50 years has been the acknowledgement of risk as being capable of being managed for.  Prior to the 1970’s the risk was the gamble.  The gamble was that the stock pick and subsequent investment in that same stock would go up in value.  Pretty simple…  Actual use of the principle of portfolio management was rolled out to institutions in the 1970’s.  In its first rendition it was called diversification.  The basic principles of diversification were:  1. Treat your entire list of investments as a unity (your whole portfolio).  The actions of the individual investments were watched to see what the net results were in totality.   2. Adjust the investments in your portfolio so the way that they interacted with the other investments produced maximum reward for the risk taken… that’s what we call optimization.  The previous sentences may seem pretty obvious today, but back then it was a new thought.  Pivotal in this summary of diversified portfolio management is the assumption that we do want to manage for risk.  In much the same way that parents may have to manage for risk during the breakfast pre-school bus hours, the critical question becomes:  Which Risk?

Previously, I have written two other articles addressing the issue of risk:  Robin Hood and the Objectification of Risk and, The Pain Chart.  You may want to read them first before proceeding.  The take-away ideas from the articles are:  Can we really anticipate risk in advance?   And, do modern risk questionnaires make it any easier?  Then I wrote:  What Is Investment Policy?   This article, summed up, spoke to the importance of anticipating a process of assessment, the results of which might not be achieved all that easily; but were worth the work.  The point of “Splitting the Risk” is that the process of attempting to assess future risk, done using a questionnaire, summed up in a written investment policy statement that is yours and yours alone in the most subjective meaning of the word, may be best fulfilled by splitting the risk.  To be clear:  it may be the best use of principles of portfolio management to address different kinds of risk with in the same portfolio.

Labeling and determining all the various kinds of risk is daunting.  Identifying the various risks would produce a very long list … a long list, which in theory might not be of very much value to investment policy.  Remember investment policy primarily has significance in that it applies only to your situation.   And the major determinant of policy seems to be:  How much money do you have relative to your personal goals?  In theory that would mean that you either have enough money or you do not.  The logic here is that if you have sufficient money you can be more conservative.  And if you have insufficient money you might want to be more aggressive.   The affliction in personal investment policy is that you have the right to do just the opposite.  So the question becomes how is one going to deal with this conundrum?  Moving back to identifying risks, let me suggest that relative to modern personal and social problems that the main risk is not having enough money.  Government, private and public corporations just cannot afford to reward employees with a pension.  A pension is defined as a guaranteed monthly income in retirement.  The pension benefit is income based.  Savings plans like a 401k, 403b, traditional IRA or Roth IRA are focused on the contribution side of things…the more you save the more you have.  The problem is, of course is that does not address the issue of whether the saved amount will be sufficient to generate enough income.  The income would in no way be guaranteed, unless private alternatives to pensions were used like annuities.  Annuities do not solve the problem of enough income; they just solve the problem of predictable income.  Thus, my suggestion, that having enough money is the ultimate risk.

Obviously the lack of money is not a portfolio risk!  The lack of money may be the result of portfolio risk.  But it is this very result that we want to guard against.  So within the modern context of lack of money equals lack of income let me suggest three portfolio risks.  Most risk is defined as portfolio volatility.  Volatility is different from absolute loss.  Volatility, negative volatility, implies that this state would be temporary.  Just how temporary is of course the topic of a whole other discussion.  Staying within the definition of risk as volatility let us break this down.  1. “End of World” risk:  50% volatility risk.  2.”Normal Market” risk: 10 to 20% negative volatility.  3. “Beat the Market” risk: risk assumed in attempting to beat a specific index, implying that you assume 100% of the risk of that index, whatever that index might be.

Here is a quick summary of what these risks are all about. “End of World Risk” assumes and implies that all risks be covered in much the same way that “the parenting skills are used in the breakfast arena moving Bobby to the bus”.   The ultimate risk management technique applied to manage volatility in “Bobby’s World” is “Be Careful”! This statement implies the futility of managing for the specific risk, “make sure you bring home the umbrella”, and instead goes for the “End of World” approach…. “Be Careful”.  “End of World” management, as defined in war like terms, may wind up shooting a few good guys.  The goal of “bringing home Bobby alive” takes on a supervening importance. “ Normal Market Risk” is an approach that is willing to assume in advance that it is NOT worth shooting some good guys as a method of protection.  A market correction is defined typically as 10% negative volatility.  Periodically the 10% correction may broaden to 20%.  This degree of risk will be tolerated.  And finally “Beat the Market Risk”  presupposes an indeterminate amount of risk that could theoretically exceed 50%.  In the past an attempt to “beat the market” presumes that more risk must be assumed to make the beating possible.  The classic statement is:  if you want to beat an established index you must take on additional risk.  My approach instead, uses the seasonal differences in the market to execute a “Beat the Market” without taking on additional risk.

Ok, let me finish on this note: why is it important to define risks into these three:  “End of World”, “Normal Market”, and “Beat the Market”?  The answer is that a growing understanding of what your investment policy should be requires a deliberately defined and protected world.  Gaining experience is clearly the answer.  The more you learn the more you know.  Being able to watch the performance and volatility associated with 3 different approaches gives you the room to grow. We at  Minich MacGregor Wealth Management are all about risk management.  The gist of this article is that there are varying types of risk.  It is possible that your success in meeting your goal of having enough money can be furthered by splitting the risk.

“Hotel policy: no pets allowed!” “Our policy is a 2 night minimum.”  “Corporate policy forbids use of social media for business purposes.”  “I am sorry; it is our policy that we do not accept credit cards.”  “I don’t know about you but it is my policy that I like to eat dinner early.”  “You know when we were kids my Mom and Dad’s policy was that we all sat down to eat dinner together… needless to say it was frowned upon to be late for dinner.”  “Stores like Wal-Mart seem to have a liberal return policy, as long as you bring the receipt with you when you are doing the return. “  “United States policy is that we do not negotiate with terrorists.”  The word “policy” crops up everywhere.  Defining “policy” is somewhat challenging since the very words that define policy are subject to definitional and usage problems as well.  My personal favorite definition is: principles or values that guide a course of action.  The operative words are: principles and values.  The easy part of the definition is a “course of action”.  If the stated principle or value is present then “this” is the applicable course of action.  So essentially you will set up in advance a course of action that is justified based on values and principles.  The heart of the matter is:  what are those principles and values?  You have to make a choice.

The choice is yours.  You can have a policy about anything.  And in an extreme sense your policy need only be justified by your personal opinion.  You can infuriate the gods if you so choose.  You can infuriate your customers if you so choose.  In fact you could have a policy that would be so totally unreasonable that your policy would be treated as ridiculous.  But, it would still be your policy!

If policy is a choice, and it is all about your choice, how do you establish what your policy is?  I think there are 2 ways.  First you can adopt the judgment of someone else.  Good example:  accepting what your parents tell you.  “Well daughter, it is my experience if you want to get ahead in life you need to put your nose to the grindstone.”  What is the principle?  Hard work pays off.  Second you can develop your own opinion based on your life’s experience.  “You know I have spent the last ten years trying to get ahead, but it was only when I put in long hours, and many years, at one project, that it began to pay off.”  What is the value?….hard work and consistency.  On the other hand, your experience and your values could be stated:  “I never got ahead until I robbed a lot of gas stations at night.”  Clearly, the wrong principle and a bad value?  Yes of course, but your policy nevertheless.  Coming to the conclusion that your policy is wrong may, in the gas station example, be the right conclusion.  But it also points out that we humans have an intuitive sense that there may be a right and wrong way to do things.  Obviously this is true.  But, it has a tendency to hold us back from making our own policy based on the fact that we may be wrong!  Stated another way: What do I know?”  “How can I be sure that I am right?” In many ways you have the right to be wrong.  It is the essence of policy that in fact you may be wrong.

Ok, so how does this relate to investment policy?  Policy is personal. Personal policy can be right or wrong.  Part of the success of personal policy is the struggle to determine what is right for you.  It is in the struggle to define what works for you that determines your comprehension of the problem.  Investment policy is essentially the struggle to define what level of risk is acceptable to you as a private investor.  The financial services industry has taken just the opposite approach to the struggle.  Questionnaires are the most popular approach to determining risk tolerance.  (Please see the Pain Chart article that I wrote.)  Unfortunately questionnaires engage in framing the question in such a way that it predisposes the answer.  And, most importantly, removes the struggle.  No struggle, no insight, no commitment to the result.

What I have seen over time, is a mortal conflict between “What I want” and “what risk can I take.” Mortal in that, high performance, and in many cases, extraordinarily high performance, is required to bridge the gap between “what I need” and “what risk I can take.”   “Based on the total of my investments for retirement, comparing it the total amount I actually need for retirement, I only need a 30% annualized rate of return!”  The assumption is that a 30% rate of return is possible but entails a great deal of risk.  Investment policy is essentially three thoughts:  1. what results do I need? 2. How much risk do I want to assume?  3. What investment strategy bridges the gap between 1 and 2?  So to be clear, investment policy is a personal choice as to what investment results are needed to reach a personal goal – typically retirement, getting in touch with how much volatility can be withstood in achieving that goal, and then matching up to an investment strategy that strengthens your belief that if you stay the course all will be well!

Now, at this point, I must beg your forgiveness.  Explaining what investment policy is, is much easier than actually defining what YOUR investment policy is.  As a way of sharpening your focus on this problem, allow me to share with you a quote from a mutual fund company’s annual report:

“We will remain concentrated and hold a portfolio of 20 to 25 high-quality securities.  However, many believe because small caps are more volatile it is better to be more diversified with hundreds of holdings.  We do not equate risk to volatility.  We view risk as the permanent loss of capital. (My emphasis)  We are diversified across industries and feel that we mitigate risk by understanding a select number of high-quality businesses that have the balance sheets and cash generating ability to survive virtually any type of market environment. “(Page 29 FAM Funds semi-annual report June 30, 2012)

This is a particularly good comment in that it uses words that are at the heart of the conflict of what risk is all about.   1.  Is 20 to 25 securities enough – if they are “high quality”?  2. If diversification is the answer to the problem of risk, how many securities need to be held in any one portfolio?  3. Is volatility defined as absolute loss (E.g., Enron) or merely the drop in the value of a portfolio?  In today’s portfolio management environment this could be the ultimate issue.  My suggested answer to these questions is why it is important to submit to the struggle of developing a personal investment policy.  My answer is that there is not a “one size fits all answer” to these questions.  For example, classic statements about how you “ought” to invest for retirement are:  When you are young you can take more risk because you have more time to recover from market downturns, when you are older and close to retirement you should take less risk because you have less time to recover from market downturns.  Do these statements necessarily apply to you?  Even if they do, is this what you want to do? Yikes!

At Minich MacGregor Wealth Management we believe that investment policy – personal investment policy – is a process.  Your policy should be reviewed frequently.  Your beliefs are shaped by your experience.  Your policy should be flexible enough so that it can adapt to your changing views.  We like to think of ourselves as providing and environment for growth and change.  The investment strategy that you pick to represent you in the ebbs and flows of the capital markets will change over time.  We have multiple strategies available to meet most investment policies.

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(Investment Policy Defined:  An investment policy statement is a document that describes a plan’s investment strategy as well as the specific needs of the plan.  A properly drafted IPS should outline the prudence and diversification standards that plan fiduciaries must follow, and should include such elements as investment philosophy, risk tolerance, time horizon, preferred asset classes, rate of return expectations, and long term goals for the plan.  In other words, the statement serves as a blueprint that is used to determine how investment decisions are made.)

This year is shaping up to be a strong year for the U.S. stock markets.

Last week, the S&P 500 was up more than 16 percent for the year, a strong gain by any measure. However, when I talk with individual investors, their overall perception is that the markets have not gone up.

This is further reinforced by recent research by Franklin Templeton, a mutual fund company. In its study, when 1,000 investors were asked whether they thought the S&P was up or down during each of the past three years, 66 percent thought it was down in 2009, 48 percent thought it was down in 2010 and 53 percent thought it was down last year. But the truth is the S&P gained 26.5 percent in 2009, 15.1 percent in 2010, and 2.1 percent last year.

Why such pessimism? I believe that investors are bombarded with so much negative financial news (thank you, cable television) that it overshadows the actual data that has been quite good. Plus, you’ve got the lingering effects of the 2008 financial crisis. Yes, 2008. Even though that crisis unfolded more than four years ago, many investors remain shaken, bitter and wary. And it’s no wonder.

Turn on any financial program and you’ll be met with dire predictions and overblown coverage of every little downturn. And it’s not just by chance. Television producers know that bad news is always a better draw than good news. Faced with 24 hours of air-time to fill, fear-mongering and fiction fill the bill quite nicely.

For example, in the past few weeks I’ve heard at least a dozen permutations of what is going to happen to the economy if the Democrats get re-elected. No, wait, did I say Democrats? I meant Republicans. That’s what’s really going to be bad. No, wait, that’s what happens if the Democrats win. But wait … you get the point.

While it’s tempting, I’m not going to suggest you throw away your television. What you should do is pay more attention to what’s actually happening in the market rather than what television programs tell you is happening. Pick up a newspaper or log on and take a look at the numbers and trends. If the market takes a real turn, consider making some changes. But otherwise, ignore the hyperbole, avoid the drama, stay calm and invest on.

Thanks to their low risk and steady returns over the past decade and beyond, bonds and bond funds have garnered a well-deserved reputation as a safe investment in a world where little ever feels safe. That safety comes as a direct result of the inverse relationship most bonds have with interest rates.

Thus, when interest rates go down, as they have done quite steadily since the mid-1980s, bond prices go up. Because this trend has been in effect for so long, many current investors have no recollection or knowledge of a time when double-digit losses on bonds weren’t uncommon. But the time for remembering — and being prepared for change — might just be upon us.

Interest rates on bonds have recently ticked back up. A good example is the yield on the 10-year Treasury which earlier this summer went below 1.4 percent, now sits near 1.7 percent.

While still remarkably low, a continued uptick in rates could have many investors facing their first-ever negative returns on bond holdings and others recalling much rockier bond times.

Now is the time to prepare.

The good news is that bonds aren’t quite as mercurial as stocks. The wild, weekly swings that you might see in the stock market rarely happen in the bond market. That’s good news as the slow pace allows you to prepare with patience. Developing a thoughtful game plan will enable you to proactively position investments if and when a significant bond market move occurs.

Part of your plan should involve looking at your portfolio and determining which investments are at most risk if interest rates continue to rise.

Consider your mix of bonds, as well. Typically, the shorter the maturity of the bond the less fluctuation of price you will see. But if all your bond funds are long-term (20 year-plus maturities), it may be time to start thinking about moving some of that money into shorter maturity bonds and bond funds.

It’s also important to note that not all bonds react the same way to rising interest rates. Some bonds, including Floating Rate Funds, High Yield bonds, and Emerging Market bonds, are more economically sensitive than interest-rate sensitive, meaning they tend to increase in value during periods of rising interest rates. Give consideration to the nature of your bond before you do any shuffling.

You also want to look at any bonds connected to your 401k. If your 401k is loaded up on bond funds, you may want to consider a Stable Fund option. A built-in option in most 401ks, Stable Funds offer a guaranteed interest rate option. While not typically a very high rate, a low steady rate is certainly better than a negative return.

Regardless of what steps you do or don’t take, the most important thing is to simply be prepared. If the market stays steady and your bonds continue to perform, all will be well. But if things start to turn, you’ll be ready to make the changes that could secure your financial future.

On the wall in many hospital and clinic examining rooms is a chart that says, “Choose the face that best describes the way you feel”.    The chart is composed of a numerical scale that uses the numbers 1 – 10.  Number 1 is “No Pain”.  Number 5 is “Distressing Pain”.  Number 10 is “Unbearable Pain”.    Any number in between is a varying degree of pain.  Smiley faces are used as visual cues as to what kind of pain might correlate with which number.

I have sat in an examining room looking at a pain chart.  I have asked myself, “So, am I in any pain? Well, no.  But, I am just in for a physical.   Maybe that’s not a relevant question, given the purpose of my visit.”  Thinking about it a little differently, “What if I was in a lot of pain?  How, then, would I answer the question?  Well I guess it would depend on what the problem was!  I could have a sore throat.  I could have a twisted ankle.  I could be experiencing paralyzing chest pain.  Would the pain of a sore throat be the equivalent of the pain of a twisted ankle?  Let’s say that I have a horribly sore throat, and possibly only a moderately twisted ankle?  Would the pain of a horribly sore throat be the same as a moderately twisted ankle?”

Roused from my convoluted conjuring of different kinds of pain I hear the sound of the door opening and the entrance of the nurse.   After introducing herself, establishing that I really am, who I say I am – “Your date of birth please?” – she then says, and I quote, “Are you in any pain?”  OMG!

I think to myself, “You know, I do experience pain at the end of 10k run.  But that is not what she means, right?”  After taking my blood pressure, counting my heart beats, she says that the doctor will be in, in just a moment.  The doctor soon shows up and says, naturally “are you experiencing any pain?!!”  Now, hypothetically, if I did say I was in pain would he point to the “Pain Chart” and say pick a number from 1-10.”

There are endless possibilities as to the semantics of pain.  There is “My Pain”:  subjective.  There is “The pain”: objective.  And, there is the reasonable man test: what level of pain would a reasonable man have, given this set of circumstances?  “Oh, you are just such a wimp!”

Allow me to change the pain experience from physical pain to financial pain.  The classic question clients get asked is:  “What is your risk tolerance?”  Notice that one of your answers could be:  “I have no risk tolerance!”  Assuming that you have some risk tolerance, the rest of the discussion, per force, is a matter of degree.  Mr. /Mrs. Client: what if the market drops 20% would you still be sanguine about the prospects for the success of your investment?  Fair question!  Mr. /Mrs. Client:  what if your statement shows a temporary drop of 50% in the value of your account?  Would you ignore this drop in value? Or, would you get on the phone immediately saying, “Sell!”  At this moment, the client could be thinking to themself, in much the same way that I sat in the examining room, thinking to myself, “Should I be feeling any pain?  If my outlook is long term what difference does a drop in value make?  Or more accurately would a reasonable man/woman in my situation objectively have pain?”

Back to the pain chart:  sensing client frustration with the “risk-tolerance-pain” line of questioning, the financial advisor remembers his or her trip to the hospital, remembering the pain chart on the hospital wall, he/she says, “Would you pick a number between 1 -10-   1 being very conservative, and 10 being very aggressive.”  After much mental struggle, you say 5.  In a sense by picking a 5 you have established 2 things:  1. you have a moderate risk tolerance, and 2. you are willing to assume the risk that a moderate person should be willing to take.

Fast forward a few years:  the market drops 50%.  (Remember, approximately every 4.8 years we have a recession.)  Assume that you are part of a very consistent review process.  3 times a year you meet in person or talk on the phone about your portfolio.  Today is your review meeting.  The question comes up:  the recent market drop.  The financial advisor says, so you must be very happy, because you picked a number 5, a moderate risk posture, your portfolio only dropped 25%.  The silence is deafening.  Your look says it all, “What, are you nuts?  That means I will have 25% less in my portfolio to contribute to my retirement income!”   The advisor is quiet for a moment and then reaching into the recesses of his memory remembering the risk tolerance interview, he says, “I thought you were a number 5?”  Once again your look says it all, “I do not care what number I picked, I do not want to lose 25% of my portfolio!”   “Well maybe you are really not a number 5, you are really a number 3” says your advisor.  The conclusion of the meeting is that your portfolio will be changed to a #3 (more conservative) portfolio.  Some months later at the next review meeting, with the market having rebounded back 30% and your portfolio is only up 15%, same type of discussion, it is decided that you are really a #7 (more aggressive)!

What is behind the pain chart madness?  My opinion is that your portfolio is no longer your rainy day money, your “ace in the hole”.  Your portfolio is your everyday money.  Your money must be safe every day.  Your money must grow every day.  Most people approaching retirement do not have the luxury of having a pension.  The financial foundation of those who retired in the early 1990’s was social security and a pension.  The trend today is: no pension.  401ks, 403bs, SEPs, Simple plans and other defined contribution plans promise only that you can contribute.  There is no promise as to what the results will be.  At the very moment that you crave stability, retirement, your retirement, is based on a murky market future.

Our objective at Minich MacGregor Wealth Management is to bridge the gap between the pain chart and the murky market future.

In 1991, Robin Hood: Prince of Thieves, a movie starring Kevin Costner was released as the first Robin Hood movie since the legendary Richard Fairbanks starred in the same role based upon saving Nottingham from the cruel Sherriff who is plotting to take over the kingdom while Richard the Lion Heart is away fighting the crusades.  The movie opens in a “Moorish Prison”, dark, gloomy; with the gloom punctuated by the moans of the sick and dying prisoners.  One of the prisoners is sitting along the wall with a hood pulled down over his face. Suddenly, like a bugle call, a scream echoes throughout the dank prison walls, a deep voice says, “The punishment for stealing, is removal of the hand at the wrist.”  The guards start to drag an old weakened prisoner to the chopping block.  At that moment, the hooded prisoner, raises his head and says, “Take me instead, for I am much younger!”  The guards look at each other, shrug their shoulders, drop the accused prisoner and grab the hooded prisoner taking him to the block.  One guard ties a rope to the wrist of his left hand pulling tight, forcing the prisoner to keep his hand aligned to the block while the other guard grabs a huge and gleaming axe.  As the guard with the axe raises it into the air preparing to swing, Robin Hood knocks his hood back to his shoulders, and looks sharply at the axe coming down on his wrist, then looks at the guard holding the rope, and in one quick motion pulls hard on the rope so that the guards wrist is pulled to the block, and the axe swings to a sickening thud into the block, severing the hand, leaving the guard screaming in pain.

The good news is that Robin Hood then uses the confusion to escape from the prison and travels back to England where he saves Nottingham for his countryman and his king.  The bad news is that Robin Hood chose to ignore his investment policy statement!  Let me explain what I mean.  Most people, who think of themselves as some kind of investment counselor, will ask a client to explain to them how they feel about risk.  Questions are asked like:  If the value of your investment drops 20% will you be able to maintain a positive outlook?  Will you recognize that the decline is temporary, and that it is all part of the ups and downs of the market place?  What is your time frame, et cetera?   The questions are designed to make you address how you will feel in the future should you lose money.  These questions come under the general category of Investment Policy.  Investment policy is a process by which you determine in advance how you will act or react to changes in the market, how you would like your investments to respond and what investment strategy best supports you and your money.  It presupposes that you can predict how you will act in the future concerning a hypothetical list of possible events.  Of course, knowing how you will act, allows the investment counselor to pick out the –theoretically- right investment.

Pretend for a minute that as a part of the investment questionnaire, one of the questions is as follows:  “You give me (the investment counselor) in the case of an automobile accident, the authority to decide in the event that your hand gets stuck in the door, how many, and which of your fingers may be cut off to free you from the wreck.  Now, for future reference, which of your fingers would you allow to be cut off in the event of an accident?” After careful consideration, you decide that you would gladly give up your little finger to free yourself from the car and save your life.  Fast forward to the dreaded day when you are in a car accident, trapped in the car, and the only way out of the car is to cut off your little finger.  Your investment counselor is there saying, “Well ,you did say in your investment policy statement, that I could give the OK to cut off your little finger in the event of an accident!”  And you think to yourself, “What, was I nuts!”  And to your investment counselor, you say, “Have you got any better ideas?”

It is my belief and experience that questions asked in the present about how you think you would act in the future do not give a very reliable answer. In the Robin Hood example and in the “car accident investment policy”, the missing ingredient is the ability to know how you will act when the actual event occurs.  Are human beings able to think about the future?  Absolutely, that is one of the ingredients that make us unique.  Our ability to be objective about future risk allows us to do, and plan to do, things that maybe would never get done.  However, this objectification never has the identical feeling of the actual moment.

Going forward, when asked about your risk tolerance, pause a moment, and say to yourself, “At the moment of maximum pain, am I really going to be that brave?”

As a parent, you have probably experienced the fun and excitement of teaching your son or daughter to ride a bike.  A new bike, with just two wheels, marks a growth stage for kids.   Kids are validated for getting bigger.  It is a sign of progress.  As a parent you know that there is going to be some accidents, falls and bruised knees.  So in order to ensure that the fun and excitement lasts as long as possible the new bike comes with training wheels.

The training wheels are attached to the rear axle, and the wheels themselves do not touch the ground unless the bike rocks to the left or to the right.  The beauty of the training wheels is that your child can sit on the bike, and start pedaling from the beginning.  The alternative is that you hold the bike, your child starts to pedal, all goes well until the pedaling slows down and the inevitable crash occurs.

The capital markets have exhibited many ups and downs over the last 2 years.  2008 was not an up and down, it was just a down!  Coming off the huge down turn, the market has, by and large, been in a trading range.  Trading range simply means that the market seems to go up to a certain level and then right back down to a previous low point.  And this pattern is repeated many times.  It is frustrating because it seems to derail any real progress for the market or for your portfolio.  And the question becomes: why is this happening?  If you think of the capital markets as the bike, and government policy as the training wheels, I think some insight can be generated.  It is generally assumed that corporations are profitable.  The profitability may have been achieved at the expense of jobs, nevertheless a very high percentage of the S&P listed corporations are very profitable.  An indication of profitability is the willingness for many companies to raise their dividend.  Cisco just raised its dividend.  GE raised its dividend.  Corporations know that in order to reward shareholders during times of modest growth, dividends build commitment.  So, if companies are profitable, then why are we in a period of low growth?  Why are we in a trading range?  The answer lies in understanding the impact of government policy.  The year 2009 began a turnaround based simply on the fact that the U.S. government starting rolling out guarantees and fixes that created confidence and stabilized the markets.  The corporate assumption – a big assumption – is that government would do what was required to keep the economy from going backwards.  Consumer demand can only survive in a positive economy.  So companies assume that the government will do its job and as a result they will continue to be profitable as well.

The bike metaphor works as follows:  the bike = corporations/corporate profits, the training wheels = government policy.  We are in a recovery.  Companies still need the training wheels.

Examples of negative government policy and hence weak training wheels:  1. Bad news out of Europe, 2. Downgrading of U.S. debt security. 3. Out of control U.S debt. 4. No action by congress on a budget.

Visualize a time when the economy moves forward on its own.  No government support is needed.  The training wheels come off.  Corporations have figured out how fast to peddle so they stay upright. Frustrating trading range goes away.